Capital gain vs. business income – sale of shares – loss on account of sale of shares adjusted against gains from sale of shares – bonus stripping – allowed. [A.Y. 2007-2008]

CIT vs. Adar Cyrus Poonawalla – (2018) 100 227 (Bombay) 

The assessee, an individual, had entered into two transactions; the first one was the sale of shares of City Parks P. Ltd. (CPPL) which were received by the assessee as a gift from his father. The assessee sold the said shares during the assessment year under consideration and earned a Long Term Capital Gain of ` 17,32,46,580/-. The second transaction pertained to purchase and sale of shares of HCL Technologies Ltd. wherein the assesse had also received bonus shares in the ratio of one share for every one share held. The assessee sold shares of HCL which resulted into loss of ` 14,95,84,935/-, which the assessee claimed as short term capital loss and set it off against the Capital gain earned on sale of CPPL. 

The Assessing Officer held that both the transactions were in the nature of assessee's business transactions and the assessee had entered into the transactions of HCL Technologies in order to avoid tax liability. As such the AO recomputed the taxable business income at ` 16,94,78,713/-. The CIT(A) accepted the assessee’s contention in respect of the sale of shares of CPPL treating the gain thereon as Long Term Capital Gains. However, he treated the loss on shares a business loss and accepted the computation made thereof by the AO.

The Tribunal however, accepted the capital gains as declared by the assessee thereby allowing the assessee’s appeal and further dismissed Department’s appeal. The Tribunal also held that there is a marked difference between the provisions of section 94(7) and section 94(8) whereby shares are specifically excluded from the operation of bonus stripping transactions. It also held that there is a difference between abuse of law and use of the provisions of law and the latter could well be used as a means to legitimately undertake a tax planning exercise relying on CIT vs. Walfort Shares and Stock Brokers – (2010) 326 ITR 1 (SC).

The Department filed further appeal before the Hon’ble High Court contending that: 

(i) the assessee is a trader in shares and the transactions of the assessee are in the nature of business transactions;

(ii) The Assessee had sold the bonus shares in the subsequent years and claimed exemption u/s. 10(38) of the Act;

(iii) The assessee had purposely entered into a transaction of sale of shares of HCL after declaration of bonus in order to reduce his tax liability by way of tax planning. The Hon’ble

High Court affirmed the order of the Tribunal holding that the entire issue hinges on the question whether the transactions in question were in the nature of business transactions or holding of shares by the assessee was purely in the nature of investment. Surely, the Revenue cannot object to legitimate tax planning. Legitimately, if the assessee had claimed set off of loss against the gain in sale of shares, the Revenue cannot frown upon, simply by pointing out that in the process, the assessee reduced his tax liability. 

The Court observed that the Tribunal had examined both transactions extensively. With respect to the first transaction of sale of shares in CPPL, the Tribunal noted that the shares were gifted by his father who himself had held the shares as investment. The company was unlisted private limited company. There was no material on record to suggest that the assessee had entered into the business venture in the process. Likewise in the second transaction also, the Tribunal noted that the Revenue has, in the preceding and succeeding assessment years, accepted, the sale of shares by the assessee as investment and the proceed was treated as capital gains. With respect to HCL Technologies, when the assessee sold the bonus shares in the later year, the Revenue treated the gain as capital gain. Thus the High Court dismissed the department's appeal and affirmed the Tribunal order.